Kentucky First Federal Bancorp 10-Q

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements Certain statements contained in this report, as well as other periodic reports filed with the Securities and Exchange Commission, that are not historical facts are considered “forward-looking statements” under the Private Securities Litigation Reform Act of 1995, that are subject to certain risks and uncertainties. These forward-looking statements may be identified by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “intend” and “potential,” or words of similar meaning, or future or conditional verbs such as “should,” “could,” or “may.” Forward-looking statements include statements of our goals, intentions and expectations; statements regarding our business plans, prospects, growth and operating strategies; statements regarding the quality of our loan and investment portfolios; and estimates of our risks and future costs and benefits. Kentucky First Federal Bancorp’s actual results, performance or achievements may materially differ from those expressed or implied in the forward-looking statements. Risks and uncertainties that could cause or contribute to such material differences include, but are not limited to, general economic conditions; prices for real estate in the Company’s market areas; the interest rate environment and the impact of the interest rate environment on our business, financial condition and results of operations; our ability to successfully execute our strategy to increase earnings, increase core deposits, reduce reliance on higher cost funding sources and shift more of our loan portfolio towards higher-earning loans; our ability to pay future dividends and if so at what level; our ability to receive any required regulatory approval or non-objection for the payment of dividends from First Federal Savings and Loan Association of Hazard and First Federal Savings Bank of Kentucky to the Company or from the Company to shareholders; competitive conditions in the financial services industry; changes in the level of inflation; changes in the demand for loans, deposits and other financial services that we provide; the possibility that future credit losses may be higher than currently expected; competitive pressures among financial services companies; the ability to attract, develop and retain qualified employees; our ability to maintain the security of our data processing and information technology systems; the outcome of pending or threatened litigation, or of matters before regulatory agencies; changes in law, governmental policies and regulations, rapidly changing technology affecting financial services, and the other matters mentioned in Item 1A of the Company’s Annual Report on Form 10-K for the year ended June 30, 2023 and in this Form 10-Q. Except as required by applicable law or regulation, the Company does not undertake the responsibility, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events. Asset/Liability Management Management and the boards of the subsidiary Banks are responsible for the asset/liability management issues that affect the individual Banks. Either Bank may work with its sister Bank to mitigate potential asset/liability risks to the Banks and to the Company as a whole. Management utilizes a third-party to perform interest rate risk (“IRR”) calculations for each of the Banks. Management monitors and considers methods of managing the rate sensitivity and repricing characteristics of each of the Bank’s balance sheet components to maintain acceptable levels of change in the economic value of equity (“EVE”) as well as evaluating the impact on earnings in the event of changes in prevailing market interest rates. Interest rate sensitivity analysis is used to measure our interest rate risk by computing estimated changes in EVE that are a result of changes in the net present value of its cash flows from assets, liabilities, and off-balance sheet items. These changes in cash flow are estimated based on hypothetical instantaneous and permanent increases and decreases in market interest rates. In March 2022 the Federal Open Market Committee (“FOMC”) of the Federal Reserve Bank began raising the target range for the fed funds rate of interest and since that time has raised the short-term interest rate by 500 basis points. At September 30, 2023, we believe our risk associated with rising interest rates was moderate. Our IRR model indicated that at June 30, 2023, our EVE was approximately 16.5%, despite the historic interest rate increases during the previous twelve months. Although general market participants believe that the FOMC will now pause interest rate increases for a period of time, our June 30, 2023 EVE is anticipated to be approximately 14.6% and 11.9% under sudden and sustained increase in prevailing market interest rates of 100 basis points and 200 basis points, respectively. Computations or prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments, and deposit run-offs. These computations should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Banks may undertake in response to changes in interest rates. Certain shortcomings are inherent in this method of computing EVE. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in differing degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. 30 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Average Balance Sheets The following table represents the average balance sheets for the six-month periods ended December 31, 2023 and 2022, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods. Six Months Ended December 31, 2023 2022 Average Balance Interest And Dividends Yield/ Cost Average Balance Interest And Dividends Yield/ Cost (Dollars in thousands) Interest-earning assets: Loans 1 $ 321,103 $ 7,087 4.41 % $ 290,100 $ 5,539 3.82 % Mortgage-backed securities 11,572 191 3.30 13,961 229 3.28 Other interest-earning assets 13,424 383 5.71 15,253 248 3.25 Total interest-earning assets 346,099 7,661 4.43 319,314 6,016 3.77 Less: Allowance for loan losses (1,840 ) (1,587 ) Non-interest-earning assets 12,341 11,873 Total assets $ 356,600 $ 329,600 Interest-bearing liabilities: Demand deposits $ 17,430 $ 16 0.18 % $ 20,905 $ 20 0.19 % Savings 55,427 112 0.40 74,545 173 0.46 Certificates of deposit 155,122 2,595 3.35 117,080 461 0.79 Total deposits 227,979 2,723 2.39 212,530 654 0.62 Borrowings 62,310 1,610 5.17 49,879 482 1.93 Total interest-bearing liabilities 290,289 4,333 2.99 262,409 1,136 0.87 Noninterest-bearing demand deposits 14,634 13,957 Noninterest-bearing liabilities 1,851 1,512 Total liabilities 306,774 277,878 Shareholders’ equity 49,826 51,722 Total liabilities and shareholders’ equity $ 356,600 $ 329,600 Net interest spread $ 3,328 1.44 % $ 4,880 2.90 % Net interest margin 1.92 % 3.06 % Average interest-earning assets to average interest-bearing liabilities 119.23 % 121.69 % 1 Includes loan fees, immaterial in amount, in both interest income and the calculation of yield on loans. Also includes loans on nonaccrual status. 31 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Average Balance Sheets The following table represents the average balance sheets for the three-month periods ended December 31, 2023 and 2022, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods. Three Months Ended December 31, 2023 2022 Average Balance Interest And Dividends Yield/ Cost Average Balance Interest And Dividends Yield/ Cost (Dollars in thousands) Interest-earning assets: Loans 1 $ 324,221 $ 3,628 4.48 % $ 297,640 $ 2,895 3.89 % Mortgage-backed securities 11,541 92 3.19 14,048 115 3.27 Other securities – – – – – – Other interest-earning assets 15,009 207 5.52 11,161 121 4.34 Total interest-earning assets 350,771 3,927 4.48 322,849 3,131 3.88 Less: Allowance for loan losses (2,023 ) (1,642 ) Non-interest-earning assets 12,136 11,948 Total assets $ 360,884 $ 333,155 Interest-bearing liabilities: Demand deposits $ 16,848 $ 8 0.19 % $ 20,234 $ 9 0.18 % Savings 54,757 55 0.40 75,546 71 0.39 Certificates of deposit 153,964 1445 3.75 112,888 224 0.79 Total deposits 225,569 1,508 2.67 205,668 304 0.59 Borrowings 68,242 762 4.47 61,965 379 2.45 Total interest-bearing liabilities 293,811 2,270 3.09 267,633 683 1.02 Noninterest-bearing demand deposits 16,110 12,738 Noninterest-bearing liabilities 1,575 1,247 Total liabilities 311,496 281,618 Shareholders’ equity 49,388 51,537 Total liabilities and shareholders’ equity $ 360,884 $ 333,155 Net interest spread $ 1,657 1.39 % $ 2,448 2.86 % Net interest margin 1.89 % 3.03 % Average interest-earning assets to average interest-bearing liabilities 119.39 % 121.31 % 1 Includes loan fees, immaterial in amount, in both interest income and the calculation of yield on loans. Also includes loans on nonaccrual status. 32 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Discussion of Financial Condition Changes from June 30, 2023 to December 31, 2023 Financial Position and Results of Operations At December 31, 2023 the Company and the Banks were considered well-capitalized with capital ratios in excess of regulatory requirements. However, an extended economic recession could adversely impact the Company’s and the Banks’ capital position and regulatory capital ratios due to a potential increase in credit losses. Assets: At December 31, 2023, the Company’s assets totaled $366.2 million, an increase of $17.2 million, or 4.9%, from total assets at June 30, 2023, due primarily to the increase in loans, net, as well as an increase in cash and cash equivalents. Cash and cash equivalents: Cash and cash equivalents increased $6.4 million or 78.6% to $14.6 million at December 31, 2023. Most of the Company’s cash and cash equivalents are held in interest-bearing demand deposits. Investment securities: At December 31, 2023, our securities portfolio, which consisted of mortgage-backed securities, decreased $1.2 million or 9.7% and totaled $11.2 million, compared to June 30, 2023. Loans : Loans, net and loans available-for sale in the aggregate increased $12.1 million or 3.9% and totaled $325.6 million and $270,000, respectively at December 31, 2023. Loans receivable, net, increased by $11.8 million or 3.8% to $325.6 million at December 31, 2023. Loans available-for-sale increased to $270,000 at December 31, 2023. Management continues to look for high-quality loans to add to its portfolio and will continue to emphasize loan originations to the extent that it is profitable, prudent and consistent with our interest rate risk strategies. Non-Performing and Classified Loans: At December 31, 2023, the Company had non-performing loans (loans 90 or more days past due or on nonaccrual status) of approximately $5.2 million, or 1.6% of total loans compared to $5.4 million or 1.7%, of total loans at June 30, 2023. The Company’s ACL totaled $2.1 million at December 31, 2023 and the ALLL totaled $1.6 million at June 30, 2023, respectively. The ACL at December 31, 2023, represented 41.0% of nonperforming loans and 0.7% of total loans, while at June 30, 2023, ALLL represented 34.8% of nonperforming loans and 0.5% of total loans. The Company had $7.7 million in assets classified as substandard for regulatory purposes at December 31, 2023, including real estate owned (“REO”) of $10,000. Classified loans as a percentage of total loans (including loans acquired) was 2.4% and 2.3% at December 31, 2023 and June 30, 2023, respectively. Of substandard loans, 100.0% were secured by real estate on which the Banks have priority lien position. The table below shows the aggregate amounts of our assets classified for regulatory purposes at the dates indicated: (dollars in thousands) December 31, 2023 June 30, 2023 Substandard assets $ 7,710 $ 7,266 Doubtful assets – – Loss assets – – Total classified assets $ 7,710 $ 7,266 At December 31, 2023, the Company’s real estate acquired through foreclosure represented 0.1% of substandard assets compared to 0.1% at June 30, 2023. During the period presented the Company made no loans to facilitate the purchase of its other real estate owned by qualified buyers. Loans to facilitate the sale of other real estate owned, which were included in substandard loans, totaled $0 and $0 at December 31, 2023 and June 30, 2023, respectively. 33 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Discussion of Financial Condition Changes from June 30, 2023 to December 31, 2023 (continued) The following table presents the aggregate carrying value of REO at the dates indicated: December 31, 2023 June 30, 2023 Number of Properties Net Carrying Value Number of Properties Net Carrying Value One- to four-family 1 $ 10 2 $ 70 Total REO 1 $ 10 2 $ 70 At December 31, 2023 and June 30, 2023, the Company had $840,000 and $854,000 of loans classified as special mention, respectively. This category includes assets which do not currently expose us to a sufficient degree of risk to warrant classification, but does possess credit deficiencies or potential weaknesses deserving our close attention. Liabilities: Total liabilities increased $18.8 million, or 6.3% to $317.1 million at December 31, 2023, as deposits increased $18.3 million or 8.1% to $244.6 million and advances increased $921,000 or 1.3% to $71.0 million. Certificates of deposit increased $23.3 million or 17.0% and totaled $160.1 million at December 31, 2023, which $44.1 million brokered deposits, an increase of $23.1 million or 110.0%. Demand deposit accounts increased $1.4 million or 4.6% and totaled $32.8 million at quarter end. Savings accounts decreased $6.4 million or 11.1% and totaled $51.2 million at the end of the current period. The cost of liabilities has been increasing rapidly due to higher costs of both wholesale and retail funding. Continued increases in liability costs, especially for wholesale funds, will primarily be driven by future increases in market rates by the Federal Reserve. It is believed that we are near the peak of this rate cycle which, if so, will likely slow the increasing costs of our liabilities. Shareholders’ Equity: At December 31, 2023, the Company’s shareholders’ equity totaled $49.2 million, a decrease of $1.5 million or 3.0% from the June 30, 2023 total. The decrease in shareholders’ equity was primarily associated with adoption of the CECL accounting standard ($414,000), net loss for the period and dividends paid on common stock. The Company paid dividends of $671,000 compared to net loss of $536,000 for the six-month period just ended. On July 6, 2023, the members of First Federal MHC again approved a dividend waiver on annual dividends of up to $0.40 per share of Kentucky First Federal Bancorp common stock. The Board of Directors of First Federal MHC applied for approval of another waiver. The Federal Reserve Bank of Cleveland has notified the Company that it did not object to the waiver of dividends paid by the Company to First Federal MHC, and, as a result, First Federal MHC will be permitted to waive the receipt of dividends for quarterly dividends up to $0.10 per common share through the third calendar quarter of 2024. However, on October 13, 2023, the Company announced that future dividends will be reduced primarily due to the recent decline in earnings of the Banks. After careful consideration, on January 16, 2024, the board determined that it would be prudent to suspend the payment of dividends completely until such time as earnings and liquidity improve. Our ability to pay future dividends and if so at what level will also be dependent on our ability to successfully execute our strategy to increase earnings and core deposits, reduce reliance on higher cost funding sources and shift more of our loan portfolio towards higher-earning loans, and the receipt of required regulatory approval or non-objection for the payment of dividends from the Banks to the Company or from the Company to shareholders. Nevertheless, management continues to believe that a strong dividend is consistent with the Company’s long-term capital management strategy. See “Risk Factors” in Part II, Item 1A, of the Company’s Annual Report on Form 10-K for the year ended June 30, 2023 for additional discussion regarding dividends. 34 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Comparison of Operating Results for the Six-month Periods Ended December 31, 2023 and 2022 General Net income totaled $(536,000) or $(0.07) diluted earnings per share for the six months ended December 31, 2023, a decrease of $1.3 million or 171.8% from net income of $747,000 or $0.09 diluted earnings per share for the same period in 2022. The decrease in net earnings for the six months ended ended December 31, 2023, was primarily attributable to lower net interest income, and higher non-interest expense, which were partially offset by lower income taxes and lower provision for credit losses. Net Interest Income Net interest income decreased $1.6 million or 31.8% to $3.3 million due primarily to interest expense increasing more than interest income increased period to period. Interest expense increased $3.2 million or 281.4%, while interest income increased $1.6 million or 27.3% to $7.7 million for the six months ended December 31, 2023. During the unprecedented interest rate increases seen in the market since March 2022, our funding sources have repriced more quickly than our assets have repriced, which has had a negative impact on net interest income. The average rate earned on interest-earning assets increased 66 basis points to 4.43% and was the primary reason for the increase in interest income. The increase in interest income was due primarily to an increase of $1.5 million or 27.9% in interest income from loans, which totaled $7.1 million for the period. The increase in interest income from loans period-to-period was due to increases in both the average balance of loans and the average rate earned on those loans. The average balance of loans increased $31.0 million or 10.7% to $321.1 million for the six months ended December 31, 2023, while the average rate increased 60 basis points to 4.41%. The average balance of interest-bearing liabilities increased $27.9 million or 10.6% to $290.3 million for the six months just ended, and the average rate paid increased 212 basis points to 2.99%. The cost of liabilities increased rapidly due to higher costs of both wholesale and retail funding. Continued increases in liability costs, especially for wholesale funds, will primarily be driven by future increases in market rates by the Federal Reserve. It is widely believed that we are near the peak of this rate cycle which, if so, will likely slow the increasing costs of our liabilities. Net interest spread decreased from 2.90% for the prior year quarterly period to 1.44% for the six-month period ended December 31, 2023. Provision for Losses on Loans Management determined that a $15,000 provision for credit loss was prudent in light of the increase in the loan portfolio during the recently ended six-months December 31, 2023. 35 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Comparison of Operating Results for the Six-month Periods Ended December 31, 2023 and 2022 (continued) Non-interest Income Non-interest income decreased $46,000 or 27.5% to $121,000 for the six months ended December 31, 2023, compared to the prior year period, primarily because of a decrease in other non-interest income, which is comprised of various items including bank-related fees and services Non-interest Expense Non-interest expense increased $174,000 or 4.4% to $4.1 million for the six months ended December 31, 2023, primarily due to higher outside service fee, as well as higher employee compensation and benefits. Outside service fee expense increased $109,000 or 104.8% and totaled $213,000 due to additional professional expenses and costs associated with them. Employee compensation and benefits expense increased $61,000 or 2.5% and totaled $2.5 million for the six months just ended due to additional salary expense and additional deferred loan costs by closing more loans. Income Tax Expense Income tax expense decreased $391,000 or 170.7% to an income tax benefit of $162,000 for the six months ended December 31, 2023, compared to the prior year period due to decreased earnings. The effective tax rates for the six-month periods ended December 31, 2023 and 2022, were 23.2% and 23.5%, respectively. 36 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Comparison of Operating Results for the Three-month Periods Ended December 31, 2023 and 2022 General Net loss totaled $361,000 or ($0.05) diluted earnings per share for the three months ended December 30, 2023, a decrease of $735,000 or 196.5% from net income of $374,000 or $0.04 diluted earnings per share for the same period in 2022. The decrease in net earnings for the quarter ended December 30, 2023, was primarily attributable to lower net interest income, and higher non-interest expense, which were partially offset by lower income taxes. Net Interest Income Net interest income decreased $791,000 or 32.3% to $1.7 million due primarily to interest expense increasing more than interest income increased period to period. Interest expense increased $1.6 million or 232.4%, while interest income increased $796,000 or 25.4% to $3.9 million for the recently-ended quarter. During the unprecedented interest rate increases seen in the market since March 2022, our funding sources have repriced more quickly than our assets have repriced, which has had a negative impact on net interest income. The average rate earned on interest-earning assets increased 60 basis points to 4.48% and was the primary reason for the increase in interest income, although average interest-earning assets also increased $27.9 million or 8.7% to $350.8 million for the recently-ended quarterly period. The increase in interest income was due primarily to an increase of $733,000 or 25.3% in interest income from loans, which totaled $3.6 million for the period. The increase in interest income from loans period-to-period was due to increases in both the average balance of loans and the average rate earned on those loans. The average balance of loans increased $26.6 million or 8.9% to $324.2 million for the three months ended December 31, 2023, while the average rate increased 59 basis points to 4.48%. The average balance of interest-bearing liabilities increased $26.2 million or 9.8% to $293.8 million for the quarter just ended, and the average rate paid increased 207 basis points to 3.09%. The cost of liabilities increased rapidly due to higher costs of both wholesale and retail funding. Continued increases in liability costs, especially for wholesale funds, will primarily be driven by future increases in market rates by the Federal Reserve. It is widely believed that we are near the peak of this rate cycle which, if so, will likely slow the increasing costs of our liabilities. Net interest spread decreased from 2.86% for the prior year quarterly period to 1.39% for the three-month period ended December 31, 2023. Provision for Cred Losses Management determined that a $9,000 provision for credit loss was prudent in light of the increase in the loan portfolio during the recently-ended quarter. 37 Kentucky First Federal Bancorp MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Comparison of Operating Results for the Three-month Periods Ended December 31, 2023 and 2022 (continued) Non-interest Income Non-interest income decreased $23,000 or 33.3% to $46,000 for the recently ended quarter primarily because of a decrease in other non-interest income, which is comprised of various items including bank-related fees and services. Non-interest Expense Non-interest expense increased $119,000 or 5.9% and totaled $2.1 million for the three months ended December 31, 2023, primarily due to increased FDIC insurance premiums and other various bank expenses. Income Tax Expense Income taxes decreased $207,000 or 183.2% from an expense of $113,000 for the three months ended December 31, 2022, to a benefit of $94,000 for the recently-ended period. The effective tax rates for the three-month periods ended December 31, 2023 and 2022, were 20.7% and 23.2%, respectively. 38 Kentucky First Federal Bancorp ITEM 3: Quantitative and Qualitative Disclosures About Market Risk This item is not applicable as the Company is a smaller reporting company.